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Beware the Dangerous Female and underestimate her at your peril! So might the tagline for Wilkie Collins' short story, The Biter Bit, have read and it's as good a place as any to launch our cautionary tale of speculation and regulation in the cryptocurrency markets.
The Biter Bit--named for an English idiom meaning "the trickster tricked"--is an epistolary novella about a bungling and overweening rookie police detective who imagines he can teach the old guard a thing or two. Taking up a case with relish as a probationary officer, Matthew Sharpin (who almost certainly obtained his position as the result of barefaced nepotism) quickly becomes infatuated with the murderess, identifies an innocent journalist as the prime suspect and settles into a series of convoluted and inept investigative strategies of which he is inclined to brag condescendingly. Believing that he is duping the murderer with his stratagems, Sharpin is nonetheless duped by the real killer--a traditional femme fatale in a mould familiar to readers of Collins' other works--thereby fulfilling the promise of the title.
And speaking of femmes fatales, here's what Janet Yellen had to say about Bitcoin in February:
It is a highly speculative asset and you know I think people should be aware it can be extremely volatile and I do worry about potential losses that investors can suffer.
Ouch. And, there's more. In May, Yellen used the R-word:
I think (for) cryptocurrencies we don’t really have an adequate framework to deal with the different issues that they pose from a regulatory perspective. There are issues around money laundering, Bank Secrecy Act, use of digital currencies for illicit payments, consumer protection and the like... And, while there are several agencies that arguably have some ability to address this through regulation, I frankly don’t think we have a framework in the United States that is quite up to the task of putting in place a regulatory framework that we need in the future. I think that’s a topic that’s well worth addressing.
Secretary Yellen's not the only public official who's been sounding the Closing Bell of Caution, either. The SEC Chair has also been flirting heavily with the idea of regime change:
Well I think that as it relates to Bitcoin and I’m not speaking to all, all the other tokens right now but as it relates to Bitcoin, while our sister agency, the Commodity Futures Trading Commission has limited anti-fraud and anti-manipulation authority, there’s no federal authority to actually bring a regime to the crypto exchanges... And I think that’s really something that we’ll be working with Congress [on].
Yikes. What price the first US Bitcoin ETF?
Ah, but Yellen can't have the Dangerous Female limelight all to herself. Here comes Commissioner Hester Peirce:
People should make their own decisions: If people don’t want to buy bitcoin because they think it’s manipulated, they shouldn’t buy bitcoin.
The DF field is getting crowded alright. But wait! DJ Cathie Wood is in da house. And she's putting her bricks where the lipstick goes, bringing a dope-looking Bitcoin ETF to the party. We can already hear it B-ARK. Question is: will investors get a bite?
Well, that all depends: Yellen, Peirce, Wood...
...which of our cast of Dangerous Females will prove to be the real killer?
As it happens, my two-bit is on Yellen (and not just because the SEC Chair would be ill-advised to ignore her). So far, the arguments about market manipulation have focused on control of the nodes which produce and verify the blockchain. As Peirce explains, Bitcoin nodes are decentralized (that's kinda, like, the point, in fact), so the opportunities for the kind of monopolistic tech behaviours that could manipulate distribution are limited. The problem is, only a crazy person would try to manipulate Bitcoin that way. To try and gain control of the blockchain would be, like Matthew Sharpin's investigative stratagems, an over-engineered and exhausting route into the problem. A token like Bitcoin exists in an unregulated ecosystem with much easier points of entry than the Bitcoin blockchain itself. (Everybody remembers how, less than three months after its launch, The DAO was attacked and $60 million of Ether (ETH) was stolen. It's not an isolated story of crypto theft.) The simplest way to manipulate Bitcoin is to print, create or steal voluminous amounts of a less robust virtual currency--JRPcoin, say--and then trade all that newfound JRP for BTC on a series of unregulated exchanges, driving the price of Bitcoin up temporarily, before it crashes again on reports of imminent regulation. This strategy wouldn't work for financial instruments sold exclusively within the traditional financial system and not just because AML controls are much stronger and compliance departments are more experienced but because opportunities for trading in JRP or Ether are limited, face greater friction and receive more scrutiny. In short, Bitcoin's problem is not so much its own character flaws but the company it keeps.
The market for Bitcoin is both unregulated and comparatively illiquid. That means that strategies for manipulation, if successful, are likely to be more effectual at driving prices. We have already seen how small ripples in the integrity of a relatively illiquid market (like unsecured interbank lending) or coordinated activity in unregulated markets (like spot FX) can quickly amplify into market events of tsunamic proportions. The more monumental the synthetic architecture built on top of shifting sands, the greater the losses when those sands are washed away.
Janet Yellen feels that viscerally--having been appointed to the Federal Reserve at a time when the scandal-ridden spot FX markets were nervy and volatile--and, in consequence, she slays.
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